The drama of banking in three acts

Cover of British Banking:British Banking: Continuity And Change From 1694 To The Present
By Ranald C. Michie
Published by Oxford University Press (£65)
(Buy at Amazon)

As recently as ten years ago the British financial sector was respected the world over. Indeed, people still used phrases such as “my word is my bond” and “as safe as the Bank of England” without any sense of irony. This trust in bankers and the City of London as a whole may now seem naïve following the financial crisis and the various bailouts and rounds of QE that followed. Professor Ranald C. Michie explains the story behind this dramatic rise and fall.

Michie is a respected financial historian who has also written a well-regarded study of the London Stock Exchange. The story that he outlines here has three acts. From the end of the 17th century and the early 19th century, the banking system emerged in the form of a huge number of small banks. Many of these banks were either badly run or too small to have a diverse base of borrowers. They either went bankrupt or ended up dependent on the London money markets, which led to the Panic of 1866.

During the mid-to-late 19th century, this patchwork arrangement was replaced by a smaller number of regional and national chains. The increased scale of the survivors allowed them to focus on lending directly to customers and business. This forced them to be disciplined, and combined with the occasional intervention of the Bank of England, ensured financial stability. While they faced strict government controls on their behaviour in the quarter decade after World War II, these were almost completely removed in the following three decades.

So what went wrong? That’s where the third act comes in, which starts with the decision to take significant powers away from the Bank of England, including its responsibility for financial regulation, in 2001. This separation, though, meant that regulators were “asleep at the wheel”. Michie also thinks that the desire to become investment banks led many institutions to rely on financial markets (originate and distribute), instead of retail depositors and customers (lend and hold), for both funding and lending. This left many badly exposed when the markets seized up during the financial crisis, a process made worse when the understandable fear of moral hazard meant that the Bank of England was initially reluctant to provide emergency liquidity in 2007.

It’s hard to disagree with Michie’s argument. Indeed, the only thing that is missing is his view of what needs to be done to prevent future crises. Although he implies that banks should be encouraged to return to the lend-and-hold model, he doesn’t really say how this could be achieved. He also overlooks that lend and hold can also fail, as it did during the savings and loans crisis in the United States in the early Nineties, where the collapse in commercial real estate brought hundreds of institutions to their knees.

While this book is aimed at an academic audience, Michie is a concise writer who gets his points across without waffle or padding. The book comes to only 270 pages, making it accessible to the general reader curious about how our financial system evolved. The author is also imaginative, using examples from popular novels to show how the reputation of banking and bankers was transformed during the Victorian era. Our only quibble is the high £65 price of the hardback. Let’s hope the publishers bring out a cheaper paperback edition.